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(1)

Nicolas Renaud

Applied Private Equity and Venture Capital

Course 2

(2)

And Now for Something Completely Different…

Basic Financial Concepts

(3)

Consolidation

Please see any good accounting book

Holdco

Sales: 1100 EBITDA: 110 NI: 16.5

Subsidiary

100% 60%

Company 1 Sales : 1,000 EBITDA : 100 NI : 10

Company 2 Sales : 100 EBITDA : 10 NI : 10

Company 3 Sales : 10 EBITDA : 1 NI : 1

30%

Company 4 Sales : 200 EBITDA : 20 NI : 2

10%

Investment Associate

(4)

Acquisition accounting

Please see any good accounting book

Assumes acquisition for EV of 250 financed by 100 of debt and 150 of equity

Repayment of Debt

-50 Company

Cash: 10 Debt: 50 Equity: 100

Company Cash: -40 Debt: 0 Equity: 100

Company Cash: 210 Debt: 100 Equity: 250

Company Cash: 0 GW: 110 Debt: 100 Equity: 150

Issuance of Debt and

Equity +100 debt +150 equity

Payment of purchase

price -210

(5)

P&L Overview

Evolution of Sales Evolution of EBITDA

Summary P&L

As of December-31 Historical Projected CAGR

$ M 2009 2010 2011 2012 2013 2014 2015 09 - 11 11 - 15

Revenue 33.1 35.9 37.1 36.0 41.1 47.5 51.5 5.9% 8.6%

Growth 8.6% 3.2% (2.9%) 14.3% 15.5% 8.3%

COGS (13.6) (13.8) (13.3) (13.8) (15.3) (17.2) (18.2)

Gross Profit 19.5 22.1 23.7 22.2 25.8 30.3 33.2 10.3% 10.8%

Gross Margin 59.0% 61.6% 64.0% 61.7% 62.7% 63.9% 64.6%

SG&A (4.4) (4.8) (4.3) (4.5) (4.6) (4.9) (5.2) (1.3%) 4.9%

Overhead Costs (4.5) (4.5) (4.5) (4.5) (4.6) (4.8) (4.9)

EBITDA 10.6 12.8 15.0 13.2 16.5 20.7 23.2 18.6% 11.6%

Adjustments vs Special Purpose Financials - (0.1) (0.4) - - - -

EBITDA adj. 10.6 12.7 14.6 13.2 16.5 20.7 23.2 17.2% 12.3%

EBITDA Margin (excl new inv.) 32.2% 35.5% 39.4% 36.6% 40.1% 43.5% 45.0%

33.1 35.9 37.1 36.0 41.1 47.5 51.5

(5.0%) - 5.0%

10.0%

15.0%

20.0%

0 25 50 75

2009 2010 2011 2012 2013 2014 2015

Net Sales Growth

10.6 12.7 14.6 13.2

16.5

20.7 23.2

0%

20%

40%

60%

80%

100%

0 10 20 30

2009 2010 2011 2012 2013 2014 2015

EBITDA EBITDA Margin

(6)

Summary Balance Sheet

 Balance sheet is always divided between short and long term

 Balance sheet present a Photography of the company

Summary Balance Sheet

$ '000 - As at 31 Dec 2011

Assets Liabilities

Accounts Receivables, Net 2,405 AP & Accrueds 1,635

Prepaids & Other Current Assets 397 Accrued Capital Expenditures 116 Other Current Liabilities 625 Total Current Assets 2,802 Total Current Liabilities 2,377

Property & Equipment, Net 60,639 Other LT Liabilities 13,236

Other Assets 416 Advances from Parent 482

Shareholders' Equity 47,763

Total 63,858 63,858

(7)

Cash Flow Statement

CASH FLOW STATEMENT

Years ended December 31,

(in US$'000) 2012F

Net income 3,667

Depreciation and amortization 5,519

Capitalized Interest -

Working Cap Requirements 27

Operating Cash Flow 9,213

Sale of Fixed Assets -

Capital expenditures (3,292)

Investing Cash Flow (3,292)

Purchase of Performance Shares -

Repayment of new senior debt (1,267)

Repayment of new subordinated debt -

Capex Financing (net) 300

Financing Cash Flow (967)

Total cash flow 63

(8)

Balance Sheet & Cash flow Statement

SUMMARRY BALANCE SHEET

$ '000 - as at 31 dec 2011

Assets Liabilities

Cash Overdraft etc

Accounts receivables Accounts Payables

Inventory ST Debt

Prepaid & other Other

Current Assets Current Liabilities

PP&E LT Debt

Goodwill Equity

SUMMARRY CASHFLOW STATEMENT

$ '000 - as at 31 dec 2011 Net income

Depreciation and amortization Capitalized Interest

Working Cap Requirements Operating Cash Flow Capital expenditures Investing Cash Flow Repayment of debt Issuance of debt Dividend

Financing Cash Flow TOTAL CASH FLOW

BS and CF can be summarized using:

P&L items

Debt items

WC items

Capex items

(9)

Forecasting through Schedules

 All important items can be adequately forecasted

using simple schedules

Debt Schedule:

Senior Debt - Beginning

Senior Debt Issued Senior Debt Repayed Senior Debt - End Interest on Senior Debt

Investment Schedule

PP&E Beginning

Maintenance capex Growth capex

Depreciation Ending Balance

Working Capital Schedule

Days of

Accounts Receivable Sales

Inventories COGS

Accounts Payable COGS

(10)

Enterprise Value

Entreprise Value - Net Debt

(all debts – Operating cash & cash equivalents) - Off balance sheet items

(unfunded pension liabilities, leasing obligations etc) - Minority interests

+ Investment in associate (at market value)

= EQUITY

(11)

Exercise

Which bank loan is best :

$1.0 M , capital payments of $200 k for 5 years and interest of 5% calculated on opening balance

$1.0 M , no capital payments until term and interest of 5.3%

calculated on opening balance

Quick Questions:

Define WC Define GW

If risk free rate go up how are valuation affected?

(12)

The Different Financing Sources Available

 In Canada / Us true Mezzanine is not

available due to absence of Mother – Daughter fiscal integration

 The goal of the

entrepreneur is to lower as best as he can his cost of capital

 Main strategy involve delaying as much as possible capital raising to optimise leverage

 Some variation include:

– PIK – Revolver – Convertible

– Mandatory convertible – Hybrid

– Bullet – Sukuk

 Equity

– Most expensive type of capital

– The only one available at the beginning and the cushion for debt investors

 Subordinated Debt

– 13% - 18%+ fairly expensive type of capital – Similar to equity but with a tax shield effect

– Used primarily for tax reasons, to increase leverage, to avoid diluting entrepreneur

 Senior debt / bonds:

– Cheapest source of capital

– Bank financing, subject to strict covenants

– Usually amortizing term loan, can be a Bullet or very fashionable currently reducing revolving facility

– Typically require a minimum equity cushion of 40%

 Subventions 1

2

3

4

(13)

The different Financing Sources Available

(14)

What is Value

 Value exclusively comes from economic profit

 Value is not price

 Companies create value by investing capital at rate of returns that exceed they cost of capital

– Spread between cost of capital and ROIC – Invested capital is CAPEX + WC

 Economic profit is the true measure of a company value:

– (ROIC-cost of capital) * capital deployed – The goal is to maximize capital economic profit

 Value of a company is the present value of economic profit:

– + invested capital of course

 This is very different than price:

– Demand meets offer

– Sum of different expectations

– No equilibrium in markets + future based pricing 1

2

3

4

(15)

Cash Flow?

 Income is not the primary goal per-se cash is the

real factor Net Income Overview

2012 2013 2014 2015 2016

Company 1 100 112 125 140 157

Company 2 100 109 119 130 141

Cash Flow Aproach

2012 2013 2014 2015 2016

Company 1 earnings 100 112 125 140 157

Net investment 25 28 31 35 39

Earnings - Investmnet 75 84 94 105 118

Company 2 100 109 119 130 141

Net investment 12 13 14 16 17

Earnings - Investmnet 88 96 105 114 124

(16)

Cash Flow vs. ROIC

 If return on investment is constant, growth is essentially a factor of RONIC and investment

rate Initial Investment

$100 $20

Return on Investment

20%

Additional Investment

$10

Reinvest 50%

$1 Return on NEW

Investment 10%

GROWTH = RONIC * Inv. Rate

(17)

Cash Flow vs. ROIC (Cont’d)

Cash Flow Aproach

2012 2013 2014 2015 2016

Company 1 earnings 100 112 125 140 157

Net investment 25 28 31 35 39

Earnings - Investmnet 75 84 94 105 118

Implied RONIC 48% 48% 48% 48% 48%

Company 2 100 109 119 130 141

Net investment 12 13 14 16 17

Earnings - Investmnet 88 96 105 114 124

Implied RONIC 75% 75% 75% 75% 75%

(18)

Note: Returns favor higher reinvestment

Cash Flow Aproach

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022

Company 1 earnings 100 105 110 116 122 128 134 141 148 155 163

Net investment 25 26 28 29 30 32 34 35 37 39 41

Earnings - Investmnet 75 79 83 87 91 96 101 106 111 116 122

RONIC 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20%

Company 2 100 102 105 107 110 113 115 118 121 124 127

Net investment 12 12 13 13 13 14 14 14 15 15 15

Earnings - Investmnet 88 90 92 94 97 99 101 104 106 109 112

RONIC 20% 20% 20% 20% 20% 20% 20% 20% 20% 20% 20%

(19)

Main valuation Methods

Main Valuation Methods

Multiples

• Easy to implement

• Less room for manipulation

• Imprecise / wrong

• Sometimes

difficult to find true comparables

Transaction multiples

• Easy to implement

• Difficult to obtain data for non listed companies

• Skewed by time

DCF

• Precise

• Theroretically corect

• Difficult to implement

• Lots of room for manipulation

LBO

• More of an

investment criteria than a valuation criteria

(20)

Free Cash Flow Formula

 To measure the cash provided by the company it is important to

remember that you want it free of the capital structure of the company

EBITDA

Reinvestment into the business

-

Tax

-

(21)

Free Cash Flow Formula

EBITDA

• Closest measure to operational performance

• least subject to manipulation

Reinvestment into the business

-

• Capex

• Working cap

Tax

-

• Don t forget Depreciation tax shield

(22)

Discount Rate: WACC

 The WACC is the best way to reflect for the structure of capital in the discount rate

Return on capital to debt holders Free Cashflow

Return on capital to Equity holders

DEBT EQUITY

Discount rate

WACC 𝐷 (1-τ) k

d

k

e

𝐷 + 𝐸

𝐸 𝐷 + 𝐸

= +

(23)

Discount Rate - Risk

 Risk is a measure of uncertainty

 As private equity investors we are not concerned about systemic risk but only about company specific risk

In finance, risk is a measure of the probability and magnitude of a difference between actual returns and expected returns

• There is 2 type of risk:

Systemic risk

Company specific risk

(24)

Variance

 Note: risk is as much a question of perception as a question of actual risk

 The measure of the actual risk of a company is unavailable to investors

(25)

Types of risk

(26)

How to measure risk

Bank risk Kd:

• Given to you by the bank who will measure ability of business to repay debt and add the specific risk (+ a margin) to systemic risk (LIBOR)

• Ex: LIBOR +300bps

Equity risk Ke:

• Most used model is CAPM : Ke = rf + β (specific return)

• Empirical evidence suggest specific return to be at 4% in equity markets

• Not really relevant in practice and more arbitrary measures are used

• 9% for equity markets

• 15 – 25% for private equity

• More for VC

(27)

Continuing Value

 Can represent most of the value of the DCF

 Very sensitive to small changes in assumptions

 Exit multiple

 Simple

 Can be misleading and should be adjusted if the entry multiple incorporate synergies or significantly different state than forecasted at exit (remaining capacity etc)

 Perpertuity:

 CFt+1 / (WACC-g)

 effectively implies that RONIC = WACC 1

2

(28)

Exercises for next time

 Can represent most of the value of the DCF

 Very sensitive to small changes in assumptions

 Demonstrate NPV formula given AoA

 Demonstrate Perpetuity formula

 Assuming a company worth $1.0 Bn has $500m of debt what is the value of the Equity. Demonstrate given AoA

 Fin a public company with Investment in associates and minority interest

(29)

Publicly Traded Comparables

key market comparables that are engaged in network and application optimization activities for telecom and other (DC, enterprise, WAN). These were split into 3 categories for valuation metrics discussion

(in USD) Trading Information

Stock Price Mark et Ent. Revenue EBITDA Gross

27/06/2014 LTM C ap. Value LTM C Y14E C Y15E LTM C Y14E C Y15E LTM LTM LTM C Y14 C Y15 LTM NTM/LTM 14/13 15/14 NTM/LTM 14/13 15/14

Hy per Growth

Palo Alto Networks $81.21 65.8% $6,259 $5,891 11.1x 8.7x 6.6x NMF NMF 40.3x $532 ($28) NMF 12.3% 16.4% 73.5% 35.9% 39.6% 32.2% NMF 78.0% 76.4%

A10 Networks $12.43 NA $746 $624 4.0x 3.2x 2.6x NMF NMF NMF $158 ($2) NMF (3.0%) 2.4% 76.7% 26.9% 35.6% 23.0% NMF NA NMF

Gigamon $19.30 (50.3%) $616 $473 3.2x 2.7x 2.2x NMF 19.8x 11.2x $146 ($38) NMF 13.7% 19.3% 76.7% 27.5% 24.1% 25.9% NMF (6.5%) 77.2%

Array Networks $1.55 126.2% $117 $91 2.2x 1.7x 1.3x 37.0x 12.5x NA $41 $2 5.9% 13.9% NA 77.2% 34.5% 30.8% 37.3% NMF 734.8% NA

Median: 65.8% $681 $549 3.6x 3.0x 2.4x 37.0x 16.2x 25.7x $152 ($15) 5.9% 13.0% 16.4% 76.7% 31.0% 33.2% 29.1% NMF 78.0% 76.8%

Mean: 47.2% $1,935 $1,770 5.1x 4.1x 3.2x 37.0x 16.2x 25.7x $219 ($16) 5.9% 9.2% 12.7% 76.0% 31.2% 32.5% 29.6% NMF 268.8% 76.8%

Developing EBITDA

Aruba Networks $17.78 0.4% $1,933 $1,633 2.4x 2.1x 1.8x NMF 9.5x 7.8x $679 $16 2.3% 21.9% 23.1% 69.4% 19.9% 23.7% 14.7% NMF 39.5% 20.9%

Barracuda Networks $31.50 NA $1,620 $1,489 6.4x 5.7x 4.9x NMF 23.7x 22.2x $234 ($0) NMF 24.2% 21.9% 77.0% 15.6% 14.9% 17.8% NMF NA 6.7%

Radware $17.13 17.2% $775 $608 3.1x 2.8x 2.6x 21.2x 15.6x 11.7x $199 $29 14.4% 18.0% 22.0% 81.1% 10.7% 11.6% 9.5% 46.8% 33.9% 33.5%

Infoblox $13.17 (67.7%) $718 $456 1.8x 1.8x 1.6x NMF 20.5x 10.8x $248 ($4) NMF 9.0% 14.7% 77.9% 1.9% 0.8% 16.4% NMF (34.8%) 90.8%

Sandvine $3.30 28.1% $496 $375 3.3x 2.9x 2.4x 12.3x 10.6x 8.3x $113 $30 27.0% 26.9% 29.4% 75.8% 18.7% 23.3% 16.5% 9.5% 45.0% 27.1%

Allot Communications $13.31 1.0% $439 $317 3.1x 2.7x 2.3x NMF 18.6x 12.9x $101 $1 0.6% 14.5% 18.2% 71.9% 19.5% 21.8% 14.8% NMF 151.4% 44.3%

Procera Networks $9.71 (36.2%) $198 $91 1.2x 1.1x 0.9x NMF NMF 8.2x $75 ($14) NMF 2.1% 11.5% 56.1% 17.9% 12.6% 16.1% NMF NMF 7.0%

Median: 0.7% $718 $456 3.1x 2.7x 2.3x 16.7x 17.1x 10.8x $199 $1 8.4% 18.0% 21.9% 75.8% 17.9% 14.9% 16.1% 28.1% 39.5% 27.1%

Mean: (9.6%) $883 $710 3.0x 2.7x 2.4x 16.7x 16.4x 11.7x $236 $8 11.1% 16.7% 20.1% 72.7% 14.9% 15.5% 15.1% 28.1% 47.0% 32.9%

Mature EBITDA

Cisco $24.70 10.6% $126,530 $96,970 2.1x 2.0x 1.9x 7.5x 5.9x 5.7x $47,202 $12,871 27.3% 34.5% 33.9% 59.2% 2.7% (0.2%) 4.6% 34.0% 3.9% 2.7%

Juniper Networks $24.47 16.6% $11,593 $9,984 2.1x 2.0x 1.9x 12.3x 7.7x 6.6x $4,780 $813 17.0% 25.9% 28.8% 62.9% 5.4% 6.7% 5.2% 73.8% 18.8% 17.0%

F5 Networks $111.11 18.7% $8,414 $7,790 4.9x 4.4x 3.9x 15.9x 11.5x 10.0x $1,592 $489 30.7% 38.4% 39.1% 82.4% 14.4% 16.3% 12.6% 43.7% 16.3% 14.6%

Riverbed Technology $20.43 30.8% $3,280 $3,327 3.1x 2.9x 2.7x 20.4x 9.1x 8.4x $1,060 $163 15.3% 31.9% 31.9% 73.3% 10.4% 10.2% 8.2% 96.4% 31.5% 8.1%

Margins Fundamentals

EV/EBITDA Valuation

EV/Revenue EBITDA Revenue EBITDA

Operating Metrics Growth

(30)

Date Ente r pr i se EV/LTM LTM EB I TDA

Anno unce d' Acqui r e r ' Tar ge t' B usi ne ss De scr i pti o n' Val ue' R e ve nue' EB I TDA ' Mar gi n

03/25/13 Oracle Tekelec Telephone service management software na na na na

02/15/13 Opera Software ASA Skyfire Labs [fka DVC Labs] Mobile video traffic software $155 37. 8x na na

02/04/13 Oracle Acme Packet Session border controllers provider $1,687 6.1x 27. 3x 22.5%

12/18/12 Cisco Systems BroadHop Policy control platforms for telecom na na na na

12/05/12 Redknee Solutions Nokia Siemens Networks (BSS business) Telecom carrier software assets $52 na na na

11/29/12 Cisco Systems Cariden Technologies Inc Telecom network design software $141 na na na

07/31/12 Allot Oversi Networks Caching and content delivery solutions $21 2.6x na na

07/16/12 CSG Systems International Ascade AB Telecom OSS software provider $19 1.2x 16.0x 7.5%

06/07/12 Citrix Systems Bytemobile Mobile traffic management software $435 8.7x na na

05/01/12 Allot Communications Ortiva Wireless Wireless infrastructure systems provider $11 1.4x na na

04/16/12 Marlin Equity Partners LLC Openwave Systems (mediation & messaging Telecom management software assets $55 na na na

02/20/12 F5 Networks Traffix Systems Telecom signaling systems provider $128 na na na

12/09/11 Thoma Bravo Blue Coat Systems Network application delivery optimization $856 1.8x 9.8x 18.7%

11/07/11 Siris Capital Group LLC Tekelec Telephone service management software $491 1.2x 9.2x 13.3%

06/17/11 Amdocs Limited Bridgewater Systems Telecom service control software $130 1.5x 8.0x 18.3%

12/10/10 PAETEC Formula Telecom Solutions Telecom billing software provider $13 1.6x na na

09/24/10 CSG Systems International Intec Telecom Systems Telecom billing software provider $267 1.1x 6.7x 16.1%

07/30/10 Redknee Solutions Nimbus Systems SL Telecom billing software provider $15 na na na

05/06/10 Tekelec Blueslice Networks Telecom data management software $35 na na na

05/06/10 Tekelec Camiant Inc Telecom network management software $127 na 7.6x na

10/13/09 Cisco Systems Starent Networks Wireless infrastructure systems provider $2,389 7.8x 19.7x 39.4%

04/30/09 Acme Packet Covergence SBC & SIP trunking hardware $22 2.8x na na

Ave r age $353 3. 2x 11. 0x 19. 4%

Me di an $128 1. 7x 9. 2x 18. 3%

Precedent Transaction Analysis

Precedent Transaction Analysis

(Figures in US$ millions)

(31)

Attractivity Band Concept

Attractively is a balance between growth and EBITDA maturity

1

Rapid improvement in EBITDA or mature EBITDA

Sale s G row th

(32)

Analysis of Valuation Categories

 Market is Segmented in 3 clear categories

Hyper-Growth Unprofitable Companies

Growing Companies with Clear Path to Profitability

1 2

Revenue Growth: ~30%

Long-term path to profitability

1 2

Revenue Growth: 15% - 25%

Clear path to profitability and significant operating leverage

Valuation

Valuation based on growth and sales multiples

Comments

Unforgiving reaction to deceleration

Valuation

Valuation based on a mix of sales metric and forward EBITDA multiples

Comments

More stable market momentum

Low Growth but Highly Profitable Companies

1 2

Revenue Growth: ~8%

Currently profitable and mature EBITDA margins

Valuation

Valuation based mostly on EBITDA multiples

Comments

Less demanding valuations

(33)

229 204

218 25

40

139 138

165 13

26

110

279 248

263 30

49

169 165

195 16

32

132 EV/Revenue LTM

EV/Revenue 2014 EV/Revenue 2015 EV/EBITDA 2014 EV/EBITDA 2015 EV/Revenue LTM EV/Revenue 2014 EV/Revenue 2015 EV/EBITDA 2014 EV/EBITDA 2015 10-12x 2016 EBITDA

Preliminary Value Benchmarking

(in US$ mm)

Methodology Implied Enterprise Value

Hyper-Growth CompaniesModerate Growth CompaniesLow Growth Mature Companies

E

Company is likely to be valued in the moderate growth category but currently there is a significant disconnect between its EBITDA-based and Revenue-based implied valuations

Assuming current valuation environment continues, an IPO in Q2 2015 based on 2016E metrics would suggest a range of 220-240 based on Revenue multiples and 110-132 based on EBITDA multiples

Valuation Disconnect

(34)

DRAFT

V. Process Considerations

(35)

Process Objectives

 Should a process subsequently and/or ultimately be undertaken, a successful process is typically expedient, minimizes disruption and realizes fair value for shareholders

 In addition to achieving a high value for the assets, one may also desire a discrete and timely process

 Critical to prioritize and find the proper balance between these objectives

Potential for a Disruptive Process

Minimize Disruption

Timely Completion

Certainty of Outcome

Attractive Structure

Maximize Value

Sale Process Alternatives

Potential for Value Maximization

(36)

Process Considerations

Shorter Process Longer Process

Concern?

Value Maximization

Greater access to a larger number of buyers requires significant investment in time and

resources to schedule meetings, disseminate information and provide each buyer with sufficient management access to solicit each party's view on value; creates better chance that winning bidder ends up being the party willing to pay the most

Market Risk/Timing

Exposure to an extended time frame increases risk of adverse market events affecting the process; consideration to known holidays and reporting requirements should be factored into timeline

Leaks

Leaks are a risk in any process and increases with the number of people and with the length of the process. Leaks can be disruptive to process - buyers walk, volatile share price, undue distractions

Employee Impact

Employees directly involved in the process will find that a majority of their time will be consumed with activities outside their day-to-day duties; a lengthy process may increase the risk of rumors and leaks and may adversely affect other employees and create uncertainty over future

Customer/Supplier Impacts Targeted Buyer Universe?

To the extent there is a limited buyer universe, a broad process may not be needed to maximize value, which would also minimize the risks associated with the market, potential leaks, employee distraction and customers/suppliers

(37)

Discrete Controlled Wide (Discussions with one interested

party)

(Simultaneous discussions with a group of interested parties)

(Wide open process with closed-bid deadline)

Advantages

Very limited disclosure

Minimize the uncertainty to employees and customers

Minimize ‘widely-shopped’

stigma

More control over process and timetable

Preferred approach of buyers (i.e., exclusivity)

High value for the business while maintaining manageable scope of process

Early indications of interest and price level for the business before proceeding with full process

Flexibility to change process, particularly with regards to selling the business to one buyer or several buyers

If sufficient interest, likely to obtain maximum value

Fairly expeditious process with uniform deadline

Widest exposure to potential buyers

Disadvantages

Negotiation tends to be sequential and can drag on

Difficult to create bidding tension

May not attract complete

universe of buyers Confidential data must be broadly disseminated

Considerable commitment of management time

Requires credible ‘walk-away’

alternatives

Process Alternatives

 The duration of a process depends on the overall objectives and ultimately the type of process undertaken

Sale Process Alternatives

(38)

Stage 1

Surface Initial Indications of Interest

Organize process

Collect data

Develop potential purchasers list

Prepare Broadcast Letter/Teaser

Prepare CIM

Initial contact made to prospective purchasers

Signing of

CAs/distribution of CIMs

Management

presentation preparation

Data room preparation

Solicit non-binding expressions of interest

Determine a short-list of partners

Short-list candidates

Reciprocal management presentations

Reciprocal due diligence

Pre-acquisition agreement

Solicit final proposals

Negotiate final proposals

Select winning partner

Finalize definitive agreements

Execute definitive agreements

Closing Preparation Stage

Approach Stage

Due Diligence Stage

Negotiation/Closing Stage

3 - 4 weeks

3 - 4 weeks

3 - 4 weeks

3 - 4 weeks

Overview of a 2-Stage Auction Process

Stage 2

Finalize An Agreement With

(39)

DRAFT

Appendix

(40)

Unsolicited Considerations

 Front Door Approach First - Buyers prefer to go through the

‘front door’ in order to source the target’s co-operation, the board support on price, and the opportunity for due diligence

– However, unsolicited offers tend to occur in situations where the bidder may be perceived to be the ‘enemy’ or where front door overtures have been rebuffed

• Most initial unsolicited bids are unsuccessful, but ultimately cause a change of control

 Best Defence - The best defence against any unsolicited proposal is to have the Company’s “full value” already reflected in the marketplace – thus avoiding opportunistic advances

 Advance Preparation – When a Company finds itself in a vulnerable position, it would be prudent for the Board to prepare for a potential unsolicited bid

 Proxy Contest – Activist shareholders may also see

opportunities to push the Board into actions to augment value in short term

– Not necessarily aligned with all shareholders as their interests are short term in nature

Early preparations for an unsolicited takeover bid can significantly

enhance the effectiveness of a defence strategy

(41)

Defence Preparation

 Understanding Alternatives – An appropriate Board response will only be possible if the Board has a full understanding of all of the company’s alternatives as early in the defence contest as possible

– Ideally prepared in advance of receiving a hostile bid – Time to respond to an unsolicited bid can be very limited

– True alternatives to an offer must be more favourable to shareholders

 Preparation – An appropriate defensive strategy prior to receiving an unsolicited bid would include a preparation stage to establish key elements of the current environment:

– Clearly understand value proposition – Communicate message to market

– Identify likely suitors and White Knight candidates – Be prepared to review business in detail

(42)

Shareholder Value Team

 Shareholder Value Team - Identify legal and financial advisors to work with senior

management and the Company’s Board or independent committee (a “Shareholder Value Team”) to carry out the necessary analysis and planning functions

 The Shareholder Value Team should undertake certain initial preparations, including:

– Review existing protection mechanisms (shareholder rights plan, key contracts, etc.);

– Consider structural initiatives and their role in any hostile take-over attempt;

– Identify and analyze potential strategic partners; and

– Initiate a “share watch” program to monitor trading of the Company’s shares

 In addition, the Shareholder Value Team should participate in the Company’s business review and initiatives to maximize value

 The Shareholder Value Team should have the confidence of the Board of Directors and the authority to respond quickly in the face of an unsolicited bid or proposal

 In response to an unsolicited bid or proposal, the Shareholder Value Team should quickly assess the strategic objectives of the offeror, estimate its maximum price payable, and analyze all aspects of any proposals

(43)

Before any bid is received, the Shareholder Value Team can take considerable steps towards an unsolicited defence review, and save valuable time should an unsolicited bid surface

Defense Preparation

Key management, legal, financial, and PR advisors

Consider potential candidates for a special committee Identify

Shareholder Value Team

Monitor share trading to detect unusual activity; may provide early warning

Identify key relationships: regulatory, political, customer, supply, lender notification/briefing requirements

Relationships should be established in advance to be able to act immediately, if and when required

Review shareholders’ rights plan

Buys time Establish Market

Intelligence Program

Receive and respond to calls, record source and nature of calls, monitor catalyst groups

Ensure shareholder sentiment is communicated to Shareholder Value Team Proactive Investor

Relations Program

Update business plan and conduct detailed business and financial review

Due diligence will be done both by the Company and a White Knight to assess value

Effective data rooms take time to assemble, which should be spent pre-bid Update Business

Plan

Refine list of potential White Knight candidates and determine the Company’s value proposition to each (ability to pay/synergies,

(44)

Planning Stage

 The initial solicitation and screening will be structured to produce a sufficient range of qualified bidders so as to establish a competitive process

 Tactical Objectives

Once a group of prospective purchasers has been selected, the objectives become:

Solicit expressions of interest

Create urgency and tension by controlling buyers and maintaining a parallel process

Develop negotiating strategies

Pursue most serious buyer

Verify candidates' financial capacity

Engage in negotiations

 Information

Information is a tool used to motivate the buyer to bid with confidence The seller should produce high quality and accurate information

It is materially more difficult to motivate a buyer to submit an aggressive offer when the quality and accuracy of the information cause the buyer to be less confident and less certain about the prospects of a business

 Process

Process should not impair the buyers' willingness to bid aggressively The sale process should be honest, fair and equal to all participants All qualified bidders should receive the same information, should have

adequate time to evaluate the information and equal access to the key participants in the process. Otherwise, certain bidders may choose not to participate to the full extent, or not aggressively

Management conflicts need to be addressed prior to launching the auction

Bid

Tension Bid

Rounds Initial

Contact Process

Tools Process

Objectives Info

(45)

Approach Stage

 The approach will be made once the planning stage is complete, and solicitation will be done in a manner to facilitate a process consistent with tactical objectives

 Initial Contact – Canaccord Genuity will initiate

– Approach approved buyers at senior level, as appropriate – Focus attention on opportunities presented by the Company

 Process Tools

– If a prospective buyer's level of interest is sufficiently high, the initial call from Canaccord Genuity will be followed by a selling packet containing:

Broadcast Letter/“Teaser”;

Confidentiality Agreement; and

Procedures Memo

 Bid Tension

– Competition is a critical ingredient to developing full value for an asset

 Bid Rounds

– A multi-phased process generates more aggressive bids

– A process which requires multiple indications of interest coupled with greater selectivity can generate incremental levels of aggressiveness with each phase (need to weigh against perception of a “never ending” auction)

– Clearly the appropriateness and extent of employing this approach is function of the level of interest

Bid Tension Bid Rounds Initial

Contact Process Tools Process

Objectives Info

(46)

Management

Presentation/Data Room 6 Definitive Agreement 4

Shareholder Lock-up 7

Exclusivity 5

Confidentiality Agreement 2

Buyer may pre-empt process and ask for period of

exclusivity to negotiate a transaction

May be provided at a late stage in the auction in return for an improved value or structure

Negotiations will ultimately result in finalizing terms in a Definitive Agreement

It is important for

management to remain open and uncommitted to all opportunities in order to help maximize value

May help if there are regulatory issues

Potential buyers will want a commitment from the key shareholders to sell at a specified price

Access to confidential materials/ management and employees

Reduces transaction risk to buyer and allows better evaluation of synergies

Detailed document articulating and supporting key selling points, business plan, financial forecast to assist a purchaser in evaluating the opportunity and assessing value in light of public information available

Binds both parties to maintain confidentiality of the materials exchanged and nature of the process

Controls public disclosure and restricts discussions among competing purchasers

Process Tools

A summary of the opportunity and key selling points sent immediately following initial contact with a potential purchaser

Entices potential interested parties into the auction process

Broadcast Letter/

Teaser

1 Confidential Information

Memorandum 3

1

Broadcast Letter/

Teaser

2

Confidentiality Agreement

3

Confidential Information

4

Management Presentation

5

Exclusivity

6

Definitive Agreement

7

Shareholder Lock-up

References

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